U6: T20 - MORTGAGE REPAYMENT METHODS

Question 1

How is a low‐cost with‐profit endowment is structured?

Answer 1

A low‐cost with‐profit endowment comprises two elements: with‐profits and decreasing term assurance. The sum assured under the with‐profits element is not large enough to cover the full cost of repaying the mortgage initially; it builds up as bonuses are added. The difference between the size of the mortgage to be repaid and the value of the policy is made up by a decreasing term assurance, so that there is always enough cover to repay the loan should the policyholder die before the end of the mortgage term. As the value of the with‐profits element increases, the level cover provided by the term assurance decreases.

Question 2

How does a unit‐linked endowment work?

Answer 2

With a unit linked endowment, the premiums are used to buy units in an investment fund. The objective is to ensure that the value of the units increases to provide a sum at least large enough to pay off the mortgage.

Question 3

Pure interest‐only is accepted for what type of mortgages?

Answer 3

Business BTL

Question 4

Define ‘Pure interest-only’ mortgages.

Answer 4

In a very limited number of situations it may be appropriate for the lender to arrange an interest‐only mortgage with no repayment vehicle.

An example is the eventual sale of the mortgaged property as the repayment method, but only where the value of the property should be sufficient to repay the mortgage. The lender cannot allow for house price inflation as part of the calculation, so the LTV of such a loan would be relatively low.

Question 5

The technical term used for the frequency of interest calculation is ‘rest’. True or false

Answer 5

True.

We have daily rest, monthly rest and annual rest calculations.

Question 6

Which of the interest calculation has the following has the fastest debt reduction?

1) Annual rest
2) Monthly rest
3) Daily rest

Answer 6

3) Daily rest

Potentially least interest over the term and quickest debt reduction

Question 7

Which of the interest calculation has the following has the highest interest paid?

1) Annual rest
2) Monthly rest
3) Daily rest

Answer 7

1) Annual rest

Most interest paid over the term: slowest debt reduction

Question 8

Many lenders will allow an existing mortgage to be switched from an annual to a daily rest basis on request. True or false

Answer 8

True

Question 9

Many lenders will allow an existing mortgage to be switched from an annual to a daily rest basis on request. True or false

Answer 9

True

Question 10

A borrower with which of the following interest calculations is most incentivised to make adhoc repayments?

1) Annual rest
2) Monthly rest
3) Daily rest

Answer 10

3) Daily rest

The daily rest basis benefits borrowers who want to make ad hoc single payments or overpayments to reduce their mortgage because the additional payment will reduce the balance immediately, whereas those on a monthly basis will have to wait until the monthly calculation date to see a reduction.

Question 11

With respect to APRC, which of the following are excluded from the total charge for credit (TCC) calculation?

A) Early repayment charges
B) Valuation fees
C) Arrangement and administration fees

Answer 11

A) Early repayment charges - not included

Also:
- endowment and other life assurance premiums;
- charges levied in respect of any default by the borrower.

Question 12

What is the second APRC?

Answer 12

For MCD regulated mortgages there is an additional requirement. Where the rate of interest or charges applied to the mortgage are variable, the lender must include a second APRC figure in the ESIS or as part of the KFI top‐up.

Question 13

True or false: Where the mortgage is on an uncapped variable-rate basis, the second APRC must use the product’s lowest borrowing rate over the previous 20 years

Answer 13

False.

Where the mortgage is on an uncapped variable-rate basis, the second APRC must use the product’s highest borrowing rate over the previous 20 years

Question 14

True or false: Where the interest rate is capped, the second APRC must assume the rate rises to the capped limit at the earliest point.

Answer 14

True

Question 15

In the first year of a capital repayment mortgage, repayments are mainly interest. True or false?

Answer 15

True. The proportion of capital repaid gradually increases as the term of a capital repayment mortgage progresses.

Question 16

Capital repayment mortgages offer borrowers the possibility of a capital surplus at the end of the term. True or false?

Answer 16

False. Repayment mortgages simply repay the borrowed capital over the term.

Question 17

Cathy has a capital repayment mortgage of £150,000 over a 25‐year term. The interest rate is 3 per cent on an annual rest basis and her monthly repayment is £711 (to the nearest whole pound). Calculate how much of the capital she will repay in the first year.

Answer 17

Annual interest paid = £150,000 ÷ 100 x 3 = £4,500
Monthly interest paid = £4,500 ÷ 12 = £375
Monthly repayment less monthly interest = £711 – £375 Monthly capital repayment = £336
Annual capital repayment = £336 x 12 = £4,032

Question 18

Greg has a capital repayment mortgage on which the interest rate has just increased. Greg’s lender has agreed that he can maintain his monthly repayments at the level prior to the rate increase. What effect will this have?

a) The mortgage term will decrease.
b) The mortgage term will increase.
c) The mortgage term will not be affected.
d) Greg’s lender will require him to make overpayments later in the term.

Answer 18

b) The increase in the interest rate means that more of Greg’s monthly repayment than originally planned will be used up paying interest. The capital will reduce more slowly and so the mortgage term will have to increase to pay off the full loan.

Question 19

One advantage of an interest‐only mortgage is that the capital is guaranteed to be repaid at the end of the term. True or false?

Answer 19

False. The availability of funds to repay the mortgage depends entirely on the performance of the investments chosen as the repayment vehicle or sufficient funds being available from other sources.

Question 20

Gordon wishes to arrange an interest‐only mortgage to buy his new property. Which of the following repayment strategies would be most unlikely to be acceptable to the lender?

a) An ISA funded monthly.
b) Allocating his quarterly bonus payments to reduce the capital balance.
c) A potential inheritance as the beneficiary of his 65‐year‐old aunt’s will.
d) A unit‐linked endowment policy.

Answer 20

c) A potential inheritance is not regarded as a credible repayment strategy.

Question 21

A second APRC figure is a requirement for fixed‐rate mortgages. True or false?

Answer 21

False. The second APRC is required for variable rate mortgages.

Question 22

The daily rest basis of calculating interest is advantageous to people who are often late with their mortgage repayments. True or false?

Answer 22

False. The daily rest calculation of interest benefits early payers, because their total interest is reduced.

Question 23

For an interest‐only retirement mortgage, it is true to say:

a) the lender must assess the borrower’s ability to meet the mortgage payments.
b) the lender is required to carry out a review of the borrower’s repayment strategy at least once during the term.
c) no regular payments are required from the borrower.

Answer 23

a) Retirement interest‐only mortgages are pure interest‐only mortgages and require an affordability assessment. They do not require a repayment vehicle.

Question 24

Which of the following is excluded from the APRC calculation?

a) Valuation fees.
b) Higher lending charges.
c) Redemption charges for sealing the mortgage deed.
d) Early repayment charges.

Answer 24

d) Early repayment charges.

Question 25

With a capital repayment mortgage, the amount of interest charged each month:

A) increases during the term.
B) reduces during the term.
C) is constant throughout the term.

Answer 25

B) reduces during the term.

Part of each monthly payment reduces the capital outstanding and, as the capital reduces, less interest is charged on the reducing balance.

Question 26

Assuming no changes to interest rates, monthly repayments on a capital repayment mortgage will:

A) remain constant throughout the term.
B) increase each month during the term.
C) reduce each month during the term.

Answer 26

A) remain constant throughout the term.

At the start of the mortgage, the lender calculates a level monthly repayment that will repay the capital by the end of the term and pay the monthly interest due, assuming the interest rate does not change.

Question 27

An advantage of a capital repayment mortgage over an interest-only mortgage is that:

A) it features built-in life cover.
B) monthly payments are lower.
C) equity in the property increases with each payment.

Answer 27

C) equity in the property increases with each payment.

Neither mortgage method has built-in life cover, unless an interest-only mortgage is supported by an endowment. Monthly payments on a capital repayment mortgage will be higher than the mortgage payments on an interest-only mortgage. As some capital is repaid each month, a capital repayment mortgage will gradually increase the equity in the property over time.

Question 28

Alfie’s lender has announced a reduction in the interest rate on his capital repayment mortgage, and a reduction in his monthly payment from next month. If Alfie decides to maintain his current monthly payments, this should:

A) increase the mortgage term.
B) reduce the mortgage term.
C) have no effect on the mortgage term.

Answer 28

B) reduce the mortgage term.

Paying more than the required amount will result in more capital being repaid each month. This, in turn, will reduce the interest charged each month, and the combination of quicker capital repayment and less interest will result in the mortgage being repaid over a shorter time. However, the reduction may have a temporary effect, because a future rate rise will eliminate the benefits unless Alfie continues to pay more than is required.

Question 29

A ‘pure’ interest-only mortgage:

A) is a conventional method for repaying residential mortgages.
B) costs less per month than a capital repayment mortgage.
C) contains built-in life cover.

Answer 29

B) costs less per month than a capital repayment mortgage.

‘Pure’ interest-only would cost considerably less than a repayment mortgage because no capital is being repaid and no investment vehicle is being funded. However, it is uncommon, particularly for residential mortgages.

Question 30

Which of the following is true of an interest-only mortgage?

A) Lenders are required to carry out annual reviews to check that any associated repayment strategy is still in place.
B) A potential inheritance would be regarded as a credible repayment strategy.
C) Lenders can adopt a more flexible approach when assessing an interest-only mortgage for a high-net-worth customer.

Answer 30

C) Lenders can adopt a more flexible approach when assessing an interest-only mortgage for a high-net-worth customer.

A review must be carried out at least once during the mortgage term. A potential inheritance would not be regarded by the FCA as a credible strategy.

Question 31

The most common investment to support new interest-only mortgages is:

A) a stocks and shares individual savings account (ISA).
B) a pension.
C) an endowment.

Answer 31

A) a stocks and shares individual savings account (ISA).

Stocks and shares ISAs are the most common investment to support interest-only mortgages, although pension freedom has increased the flexibility they offer as repayment vehicles. Endowments were the most common investment vehicle until evidence arose of poor performance and mis-selling.

Question 32

Which method of calculating mortgage interest would result in the lowest total interest payable over the mortgage term, assuming the borrower paid on time and made additional ad hoc payments?

A) Annual rest.
B) Monthly rest.
C) Daily rest.

Answer 32

C) Daily rest.

With daily rest, interest is calculated daily and payments are credited immediately. If only the scheduled payments are made, this method will not cost less than monthly rest. However, if additional payments are made, this will reduce the total interest payable.

Question 33

Which of the following is an assumption the lender must make when calculating the annual percentage rate of charge (APRC)?

A) The initial rate of interest will apply throughout the term.
B) The mortgage may be redeemed before the end of the term.
C) Life assurance premiums are included in the monthly cost.

Answer 33

A) The initial rate of interest will apply throughout the term.

The lender must assume the mortgage will run until the end of the agreed term, so no early repayment charges would be included, and life assurance premiums are specifically excluded from the calculation.

Question 34

A second annual percentage rate of charge (APRC) is not required for which of the following MCD regulated mortgages?

A) Variable rate.
B) Capped rate.
C) Fixed rate.

Answer 34

C) Fixed Rate

The second APRC is required for MCD regulated mortgages where the rate of interest is variable. This includes capped-rate mortgages

Question 35

Capital repayment mortgages offer borrowers the possibility of a capital surplus at the end of the term. True or false?

Answer 35

True.

The proportion of capital repaid gradually increases as the term of a capital repayment mortgage progresses.

Question 36

Jenny’s mortgage is on an annual review basis, and the last review was held on 31 December a year ago, when the interest rate was 4%. What would be the consequences if interest rates then rose from 4% to 5% from July to December?

A) The capital owed would have reduced on 1 January this year.
B) The capital owed would have increased on 1 January this year.
C) There would be no difference in the capital owed.
D) Jenny’s mortgage payments would reduce from 1 January this year.

Answer 36

B) The capital owed would have increased on 1 January this year.

Question 37

Retirement interest-only mortgages require the lender to review the repayment vehicle at least once during the mortgage term. True or false?

Answer 37

False. Retirement interest-only mortgages are pure interest-only mortgages and do not require a repayment vehicle.